This is guide to trading with Fibonacci numbers. There are many tools based on Fibonacci. You will learn how to use most popular like Fibonacci Retracement, Fibonacci Extension and Expansion. You will also learn how to build a trading plan based on Fibo tools.
This is rather long guide and I hope it will help you to build your own trading plan. I show you some examples of entering and closing positions, but remember that in the end you are responsible for your trading results. I do not take responsibilities for your trading results and I do not give any kind of guaranties that with this guide you will make money. This is an educational material, not ready system.
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Updated: march 2019
What was updated: This is a guide which I wrote in 2010.
The main difference on an example
Let’s have a look at the same trade.
The first investor makes his decisions based on the trend following system. He is using the Stochastic oscillator and two simple moving averages (SMA) – 10 and 20. According to his system, you have buy signal when Stochastic is oversold and there is a cross of 10 MA over 20 MA. The exit signal is when 10 MA is back below 20 MA.
Here is the trade example:
The entry point was very late because of the fast move of price and the late cross of MAs. The exit signal was also very late.
The other trader is using the Fibonacci technique. He chooses swing, draws the Fibonacci retracement levels and waits for an entry signal at correction. When the signal occurs, he pulls the trigger and enters the trade. He draws the Fibonacci extension levels to project possible take profit targets. After a while, when his target was hit at the extension, he closed the trade and took profit.
Naturally, both examples are simplified, so that you can see the difference more clearly. Don’t worry if you don’t understand the second example. When you finish this guide, this will be an easy thing for you to do. For the time being, just follow the decision process of the two traders.
Mind when the first trader made his decision to enter the trade. Look when he closed it. He was late with entry and late to close it with profit.
Now take a closer look at the second trader. Again, it is the same chart, same day, but the second trader is using different tools. Notice that his enter and exit decisions were made long before the first traders! He made more money on the same trade and exit when the first trader was still hoping for continuation of the trend.
This is the main difference between traders using lagging indicators and those using leading indicators.
Lagging indicators are based on prices from the past. It may be a price that was open, close, low, high, but a price from the past in all cases. It does not matter if you are using MACD, moving averages, RSI, CCI or other oscillators. They all are lagging indicators and they give signal after it took place, like we could see in the first example.
The Fibonacci tool, on the other hand, is a tool belonging to leading oscillators. These give you support and resistance levels for the price before it even gets there. You should decide or use others tools to take the most probable signal. There is a whole chapter about choosing best signals later on in the guide, so you will understand it better. Using the leading indicator let the second trader get ahead of the rest people using lagging indicators. This is the main reason why so many investors are not profitable. Professionals use leading indicators to be the first to enter and exit the trade.
Soon enough you will join this group!
Where do Fibonacci numbers come from? What is Fibonacci sequence?
I will try to make the Fibonacci topic simple and comprehensive. In a moment, we will focus on Fibonacci trading, but some basic topics have to be explained.Try to understand them well. Do not worry; it is not as complicated as you think!
Leonardo Pisano Bigollo was born around 1170 in Italy, he is also known as Leonardo Fibonacci. This italian mathematician introduced the Fibonacci sequence to the western world in his book Liber Abaci. What is interesting, this sequence was known to Indian mathematicians back in six century.
The Fibonacci sequence is present in many different areas, such as mathematics, nature (spirals of shells or tree branches) and, of course, in Fibonacci trading! If you are interested in other areas that you can find this, you should read a publication about Fibonacci numbers.
Firstly, a few words about Fibonacci numbers. What are they, anyway?
Fibonacci numbers are the sequence of numbers startingas follows: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 337, 610, 987…
They are called Fibonacci sequence or Fibonacci series.
Each number is a sum of two previous numbers (two to the left).
Look at number 3. It is the sum of number 2 and number 1, because 2 and 1 are to the left of 3.
The two numbers to the left of 34 are 21 and 13. So, we add 21 to 13 and the resultis 34.
This is the answer to where Fibonacci numbers came from. Each Fibonacci number has its own place in the sequence. The Fibonacci sequence is the base to calculating other Fibonacci numbers, such as ratio or extension.
What is the Fibonacci retracement and Fibonacci ratio?
Based on the sequence, we can calculate the Fibonacci ratios and Fibonacci levels. The Fibonacci ratio is counted by dividing a number by the number that follows it in the sequence. Let’s take a look at some Fibonacci levels:
The last ratio listed: 61.8% is the most important ratio and is often called the golden ratio or the golden phi. But there are more ratios, as you have noticed. Where do the other ratios come from? The answer is simple: it is the result of dividing a number standing two, three and four places to the right.
For instance, two places to the right from 8 there is 21:
Three places from 8 there is 33:
Here we have them – the most important ratios: 23.6%, 38.2%, 61.8%.
A ratio is also called a retracement level or Fibonacci level. It is because there is a chance that a price will stop and reverse at one of those levels.
Traders like to use a few Fibonacci levels more, so the list of most popular full retracement levels is as follows:
23.6%, 38.2%, 50%, 61.8%, 78%
The 50% retracement level does not come from the Fibonacci sequence, but it’s an important level. Traders tend to react when a price level is near half of the previous swing, so they added it to retracement levels.
So that is how with help of Fibonacci ratios we get Fibonacci levels.
Before we learn more about the Fibonacci retracements, let’s focus on price behavior for a minute.
Let’s start from one tricky question and the basics of price behavior. In which direction can price move? You will probably answer: up and down. This answer is correct, there is a “but” though. What if there is no main trend? If there is no strong trend, the price will probably move sideways. Statistics say that the price is moving about 30% of time in a trend and rest of this time it is moving in a range. Why is moving in a range such a bad thing? It is because there is no clear direction and the price moves up and down, so it is very hard to make money inthis kind of movement. Have a look at the chart below, is it the way you would like to trade in?
No, it is not. It is a very tough market to stay profitable in. Unless you like to trade in a range (there are trading strategies which work best in range market condition), you should avoid this kind of market. The best way is to wait until it is over and then start to make money when the trend is back.
Price can be trending up, down or move sideways. Of course, we look for investment opportunities in an up and downtrend, trying to avoid investing when there is no clear direction.
Let’s assume that we have identified an uptrend. Does the price go up all the time? No, it makes higher highs and higher lows. This is a sign for us that there is an uptrend. It may look similar to the example below:
It is similar with the downtrend. The price makes lower highs and lower lows. Again, look at chart below and you should understand it right away:
Can you see the clear sequence of this move? There is certain noise around it, but you should be able to spot significant highs and lows.
This behavior gives us important information. First of all, we are able to identify the current trend. When we are able to see the higher highs, we can draw the Fibonacci retracement levels. Identification of the turning points (higher highs and higher lows or lower highs and lower lows) is necessary to draw retracement correctly. You can read how to draw it in a little while.
Remember: in some unusual cases the price will go straight up or down. This happens mostly when some unexpected news is causing panic or euphoria among investors. It looks promising on a chart, but trading this is very hard. You have to take your position early; otherwise, later your entry point will be very risky.
How to draw the retracement levels? It is easy like ABC
So far, we have learned that it is very rare for a price to move in one direction for a longer time. Surely, when there is panic or euphoria on the market because of some big news, prices may skyrocket and it is hard to enter the trade.
In most cases though, the price moves in zigzag shapes. Some traders call it waves, and there is a scientific concept called Elliott wave theory. But for us, it is important to know the nature of these moves. First, we need to identify a swing move that is a move from point A to point B. We know already that after the main swing there should be a correction in the opposite direction to point C. When we see a move from point A to B, we wait for a move down (correction) to point C. Point C should be located between points A and B. On a chart illustrating an uptrend it may look like this:
It is not always so easy to identify points A, B, and C, but it gets easier with time and experience. When we are sure that we have found the ABC move, we can draw a Fibonacci retracement with a tool from our chart software. We start from the low of swing to the high, so from point A to point B.
If you use candle charts, you should draw from the low of the shadow (or peak) of a candle to the high of a candle. Please, notice that you get much more accurate results when you apply the retracement levels to your candle chart. Compare it with the results from the above chart.
How do you know if you have chosen the right top and bottom? It is a little bit like art and comes with time. At times, when you have two bottoms nearby, even if you have selected the wrong one, it is not going to change the position of the retracement levels so much. Just practice on the price history.
Should the price touch the retracement levels?
This is always a problem for new investors. They think that the retracement to point C is only valid when the price touches down this Fibonacci level. They are wrong. Fibonacci retracements are a great tool, but there is no 100% accuracy. Sometimes the price closes near the retracement level and it can be still a valid move. Just look at the example below.
In a downtrend, there was a correction up. The price looked as if it would move up to 50% retracement level, but it did not happen.
We look at candle close here and we can see that both candles closed below the 38% level so this was our point C and 38% retracement was a resistance for the price. Next, the price moved back to a downtrend. On numerous occasions, the price will touch exactly specific retracement level. However, be aware that sometimes it may not look that perfect.
What retracement levels should I use?
It is very confusing at the beginning because there are many Fibonacci retracement levels and some people use only specific ones, while others like to draw all the retracements. My advice is to try to use the standard levels. Over time, when you gain more experience, you will decide which are the most important ones and which ones you prefer to use.
So, which levels should you start with?
Why use the 50%? It is not a Fibonacci retracement, but still an important level (half way up or down), so traders like to keep this retracement level together with other proper levels. Stick to these levels and it should be enough to trade well when it comes to price correction.
I have my retracement lines, when should I open a trade?
Now you know how to draw the retracement lines. Thanks to them you can enter a trade with a better price, which is always a good thing.
But when should you enter a trade?
That is the biggest challenge after drawing the right retracements levels. You can find a more specific information about entering a trade in Part 5. Before you read that part, it is important that you understand the options you have when the price is nearing the retracement line.
After drawing the retracement levels with help of Fibonacci retracement tool (available in most charting softwares), you should decide when you want to open your position. You have three options to choose from, but before further explanation, check the chart below.
I do not want to complicate things too much, so I have used a line chart, but in real Fibonacci trading, try to use a candlestick chart:
We have confirmed that the main trend is strong and is up. After a swing high move from A to B, there was a strong correction, so we have drawn the retracement levels. We are waiting to take a long position because the main trend is up.
Now we have three options for doing this.
You look for best Risk Reward ratio or you want to trade between A and B. For example, when the price reaches the 61.8% retracement, you go long at this level or a little bit above it. This level is very popular among traders and it works on many occassions.
You can take the same action at 50% or 38.2% if you think that the correction ends there.
So to sum this up. You look for entry near or at retracement line which you believe is point C. Your stop loss is rather tight so your risk reward ratio is very good.
The second option is when you wait and watch how the price reacts with retracement levels and you wait for confirmation. It could be many things, such as a confirmation from an oscillator or moving averages or price pattern. Remember – simple trading rules can work great, just write them down in your Fibonacci trading plan. When there is a confirmation signal, you go long. Of course, confirmation signals are not always 100% correct, but in that case, you have a lower chance of failure. This, in my opinion, is a better way to enter trades. The ratio between risk and possible profit is still very good. In this example, the trader decided that the signal will be a close of price above resistance.
As I have mentioned, you have to decide and test yourself what signal works best for you.
In the third case, you wait until the price breaks above the recent high (the one you have used to draw your retracement levels – point B).
Personally, I used to trade according to the third scenario very often. That changed a lot. I avoid this entry because Risk Reward is not that great in this place. Also, on breakouts you have many traps. Still, there are times when I trade breakouts but in this cases I wait for retest. More about it later.
Which way is the best for you? I believe two first options are best. We will have a closer look at them later in this guide.
Where to put stops?
The Fibonacci retracements are great when it comes to placing stop losses. Let’s assume that you have a long position opened after a correction to point C. Where should you place the stop-loss order? I like to put it at point A, that is, below the place where the swing move started. If the price moves back down below point A, there is probably something wrong with the trend strength.
Below, I marked 3 possible places where you can place your stop loss order in such a case:
It all depends on how aggressive you want to trade. Sometimes I place the stop loss just below the 78% retracement line. If you want to place a tide stop loss, you place it below the retracement that you think is your point C.
The good thing is that, over time, you will understand the behavior of the price better and you will be able to place the stop losses in better places.
There is more about the topic in Part 5, where entering a trade is discussed in detail.
The retracement and trend lines
Sometimes the price trends very nicely and it is easy to see the trend line. In such a case there is a strong chance that when it comes to a correction, it will end at a Fibonacci retracement level closest to the trend line.
Fibonacci works great in the trending markets, so it is a good idea to combine Fibonacci retracement tools with trendlines. First, you have to draw a trend line.
Let’s assume you are waiting for a retest of this line. In the meantime, you can also draw the Fibonacci retracement levels from a low to high swing.
The correction ended at the 61.8 retracement level and the price touched the trend line. As it turned out, it was a great point to enter the trade.
You can play this scenario by entering the near retracement level and trend line. You put your stop loss below the trend line, but not too far from it. With a strong trend in place, you assume it is a low-risk entry.
It does not always work this well, but sometimes it does. You have to be very watchful about these kinds of price behavior, because these are good points to enter a trade. The potential risk of loss is small and the potential profit is big.
The Fibonacci retracement and support
Another great way to predict where the price move might end is combining the retracement lines with support levels. It is very simple to do. First, you have to check if there is an important support/resistance level near to the retracement. We look for a few types of support. It may be a support from previous important highs, like in the example below:
Let’s say that we want to take a long position after a break above this resistance (so we look for a trade in the area near the right side of the chart). On the lower time frame, we can spot swing and correction very fast, down to the 61.8% retracement. If you take a closer look, the correction ended almost exactly at the blue line, which now acted as support (because before the price had closed above that line).
Some traders probably took long positions only because price moved back to the support (blue) line. But you know, with your knowledge about Fibonacci, that when an important support line is in the same area as the retracement level, then it is a trade you should consider to take because there is a much better chance of success.
Another great way to look for support is to use Fibonacci retracement tool with moving averages. You probably know that some popular averages work well as support and resistance.
What are these moving averages? They are 10, 20, 50, 100 and 200 periods long.
Some traders may say that there are more important averages, but this is something you should decide based on your trading style. From the above set of averages, the most important are the longest ones: 50, 100 and 200. When the price moves back to 200 MA, there is a chance it will find a support there. If you can connect this level with the Fibonacci retracement, you have a potential good entry point.
Below there is a 4-hour chart of SPX. You can see that the price is above the 50 moving average. After a swing, there is a correction down to that moving average and the 50% retracement level which is in the same place. This is obviously a good point to look for an entry.
Take a good look at this combination, because, on numerous occasions, this is a good place to enter the trade. Not all traders use the Fibonacci retracement for an entry. Some traders tend to enter or reenter a trade at a moving average because they know that this is good support. You should join this group, but only when you have another confirmation from the Fibonacci retracement.
When do you earn money?
There are two similar tools to project where the move can end:
1. The Fibonacci Extension
2. The Fibonacci Expansion
It is confusing at the beginning, but I am going to explain the main differences so you can have a good understanding of the subject matter.
Why are the Fibonacci projections so important?
I have seen many cases when people opened the trade at the right moment, for the next few hours or even days the trade was profitable, but they hesitated to close it and ended up with a loss.
The most important thing to remember is that you earn money when you close the trade and book profit from it! If your position was opened two days ago and it is profitable then good for you. But until you close the trade and take the profit, it is virtual profit. It changes all the time. There might be some big news, the price will move against you and in a couple of minutes, you will be counting how big your loss is.
This is the reason why closing trades is so important in Fibonacci trading. For me, closing trades is far more important than opening them. Even a poorly executed trade can turn out to be profitable if you exit at the right moment. But when is it the right time and place to take the profit?
The Fibonacci projection is very helpful in solving this problem and I am sure you are going to enjoy it.
Tool 1: The Fibonacci expansion
Let’s start with the Fibonacci Expansion, which is based on three points. To draw it we have to identify swing low or swing high and the correction. Yes, it is exactly like it was with the retracements and looking for points A, B and C. We use the same ABC points. As you remember, we have to identify the swing and correction. Points A and B are marked at the swing ends, C is at the point where the correction ended.
How to draw the expansion levels?
In Metatrader, from the top menu select Insert → Fibonacci → Expansion. Run a trend line from point A to point B.
Next, you have to click on the end of the second line and move it to point C – where the correction ended.
Now you have the possible levels (projections) where the move may end or stop for a while. The three most popular are: 61.8, 100 and 161.8.
Here, the move stopped at two points – the 100 and 161.8 expansion:
How is it calculated?
The expansion levels are drawn from point C:
• Target 61.8 is 0.618 times of the distance between Points A and B
• Target 100 is 1.000 times of the distance between Points A and B
• Target 161.8 is 1.618 times of the distance between Points A and B
That is why in the above example the first target (61.8) is below point B. The correction was deep.The 61.8 target from point C ended below point B. Why? Because 0.618 distance between A and B ended at this place.
In another example, we will try to find the expansion in a downtrend. First, we need to make sure that the downtrend is strong, and then we wait for a swing AB and a correction to C.
We start from drawing the expansion from A to B:
Next, we move the second line to point C (where the correction ended):
The expansion levels are now drawn correctly. In this example, the price moved down to the 161.8 expansion, but as you can see after the next correction, the downtrend has continued. It was a great opportunity to use the expansion levels on the next waves of that move.
It gets easier when you practice it yourself. Remember, you have all this historical data to practice with!
Tool2: the Fibonacci extension
The Fibonacci extension is based on the first move (A to B). Point C is not used for calculation here.
The Fib levels are drawn from point B.
For example, the 138.2% extension level equals the 38.2% distance between A and B, which is drawn from point B. Look closely at the chart below, where I marked the distance:
For the 161.8% extension line, we take the 61.8% distance between A and B and add it to point B.
Now you can see that point C (where the correction ends) does not matter in the calculation. We only care about the swing from A to B and this is our base to calculate the extension lines.
It may seem that this method is less accurate because for the expansion we use 3 points. The truth is that it is also very accurate despite differences in calculation. Personally, this is my favorite way to look for the price projection and later in this guide I will mostly use this method.
Before we go further and learn more about the extensions, you may want to add them to your Metatrader chart. Look for instructions at the end of the guide.
This way you will be able to draw the retracement and extension at the same time! It is handy and saves you a lot of time.
The Fibonacci extension in practice
In the example below, you should be able to find points A and B. We can use them to draw the retracement levels as you remember from the previous chapter.
In this case we do not pay attention to where exactly the correction ends. Point C will be somewhere between A and B, but in order to calculatethe extension we need only A and B. This is what happend next:
The correction ended at the 78% retracement level and the price went down to the 127% extension line. It closed almost exactly at this Fib level and right after we noticed a very strong bounce up.
In another example, we can also spot a correction down to the 78% retracement. From here, price moved up strong up to the 138% extension where it stopped for a while. Later the price moved up to the 161.8% extension which was a very strong resistance for a long time.
Actually, the price did not move above that level and sellers took control.
Later I will present more examples of trades and signal confirmations. For now, it is important for you to understand the difference between the Fibonacci extension and expansion:
Expansion -> 3 points (ABC) to calculate the expansion levels
Extension -> 2 points (AB) to calculate the extension levels
Both tools are great. You can plan your exit points and book profits thanks to them. My favorite one is the Fibonacci extension, so in the next trade examples I focus mostly on that tool. If you like the Fibonacci expansion better, feel free to try it out and build simple Fibonacci trading strategies around it. The expansion is used by many traders as well, so maybe it is the right tool for you?
Which extension levels are most important?
There are so many projection levels that you might be confused which ones are the best in practice. To tell the truth, there is no single rule, such as “always close at the extension of 138%”.
Some traders like to draw only a few levels on their charts to keep things clean, but they are aware of the fact that the price might stop at other levels.
I use most often levels like: 138.2%, 161.8%, 200%.
Other levels, such as 127%, 150% or 261.8% are also important and can stop the price action. Over time, you will decide on your own if it is a good idea to keep them all on the chart or only a few. For now, you may stick to the most common extension levels.
It is all about probability
It is important to learn to watch closely how the price reacts with the projection levels.
You do not know in advance where the price will stop. The projection levels are only levels where there is a POSSIBILITY that the price may stop.
It also does not mean that the move will definitely end at the projection level. Sometimes the price stops for a while, and later, if the trend is strong, the move continues.
In other cases, the move will end at the price projection and it may even be the end of the current trend. That is why you should learn how to watch for the price reaction with the projection levels and to your signals.
Still, you are in a much better situation than other traders. You know in advance the possible levels where the price may stop. You will learn in Part 6 how to use it to your advantage.
The convergence can be very useful, but many new traders do not know or remember to look for it. It is not that complicated, which I will show in this chapter.
Before you start to look for Fibonacci convergence you should feel comfortable with using the Fibonacci retracement and extension levels. You should be able to easily choose the price swings to draw them. If you are not that experienced, do not worry! Just read this chapter or skip it and return to study it later when you will have more experience in using the retracement and extension.
At the beginning, I wrote that the price moves in a zigzag formation. I showed you how you can choose the swing to draw the Fibonacci retracement or extension. Trends are built upon many different swings.
The convergence is a situation when you draw the Fibonacci retracement lines for more than one swing and when some of the levels are close to each other.
In the example below the price moves up making many swings. There are a couple good points to choose to draw the Fibonacci retracement. Which one would you choose?
The one below is very easy to spot, so of course we can use this low and high and draw the retracement levels:
We can also use high and low from a bigger move, where the price moved back to the 38.2% retracement line. This is the same chart as the one above:
When we put these two Fibonacci levels together, we will see that some of them are very close to each other:
You can notice that the first convergence level was 38.2 (red) and 23.6 (blue), but the price did not stop there. The second level of convergence was at 61.8 (red) and 38.2 (blue). The price found strong support and from that point, the uptrend continued.
Part 5. WHEN TO ENTER A TRADE – FIRST SCENARIO – OPENING A TRADE ON BREAKOUT – FIBONACCI TRADING STRATEGY
When to enter – opening a trade on breakout
There are many different ways you can enter a trade with the Fibonacci tools. One of them is to open a trade on breakout.
Should you use this method
I do not recommend to trade this scenario.
Reason is simple – breakouts are very popular among some traders and market makers know that. Because of that we can see many false breakouts, bulls traps, bears traps during breakouts. I used to trade breakouts alot but now I simply look for entry at retracement line which works much better.
Still, there are times when you want to trade breakout. If you do, then the best way to trade it is to wait for a retest.
The game plan
The main idea is to buy when the correction ends and there is a breakout. We are looking for a place where there is the best chance to enter at the right moment and into the right direction. The place is a break above recent high in an uptrend or below a recent low in a downtrend.
In theory, it should look like in the picture below:
The game plan is simple:
1. Identify the main trend (you can read the instruction in Part 7). You should know what the main trend is and in which direction you will be looking to enter a trade.
2. Identify the low-high/high-low swing. Find the swing which you will draw the retracement and extension lines for.
3. Wait for the end of the correction to part C. Let other traders play between the retracement lines. Just be ready and wait to enter the position.
4. Wait for the breakout above the high from swing A-B (to go long) or below the low from swing A-B (to go short).
5. Wait for retest – usually this will be a retest of B point. Switch to lower timeframe so you can enter on retest. For example, if you trade on 1h timeframe, go to 5m or 15m and look for a retest here.
7. Open a trade.
8. Wait until the price hit the extension line and close the trade at point D
How Fibonacci levels help us here
There is one huge difference between a Fibonacci trader and an ordinary trader. The latter is not sure when he should close the trade opened after a breakout. He has opened the position at the right time (at the breakout), but he has no clue where to close it. He has some exit signals, but he is usually late with his exit decision.
A Fibonacci trader is able to get the most part of a move from the moment of the breakout. With the Fibonacci extension tool he can, on many occasions, exit almost exactly at the end of the move (it is not the goal of this Fibonacci trading strategy, but it will happen to you many times).
Your exit point will be at one of the extension lines (more about closing positions in the next part). Your goal is to catch most of the move between 100% and the extension line, so between 100% and 127% or 138.2% or 161.8% etc.
Breakout and retest – what is it about?
As I mentioned before, if you want to trade breakout it is best to wait for a retest. Here is why.
In this example you can see a support line which worked few times. Eventually, price managed to close below it (we had a breakout). Now this is a crucial moment. Is this a false breakout or is this a moment when support turned into resistance?
That is why we wait for a retest. When there is a retest and we see that old support works now as a resistance (we see that based on price action) then it is a good place to open a trade with tight stop loss.
Remember, sometimes retest will be visible on lower time frames and that’s the reason why in this case it is a good idea to look for entry there.
Below there is a 4-hour chart of GBP/USD. From a higher time frame, we know that the main trend is up. There is a deep correction (down to the 61.8% level, C point). At this point, we are still waiting for a breakout. After a while, there is our breakout above point B (recent high). The green field marks out our potential profit zone (it could get even higher), that is everything between point B and the extension lines.
The disadvantage of this scenario is that sometimes the price will explode through a recent high/low and it will be hard to join the movement. Do not worry – it happens sometimes. If you miss it, just wait for another correction. Sooner or later, there will be a strong correction, and maybe a better opportunity to enter the trade.
In the next example, we can see a 4-hour silver chart. The main trend is up, so we want to buy silver. Finally, we identified the AB swing and waited for a correction which turned out very mild. Our entry point is when the price closes above point B, which, in this case, was very rapid. Take a close look at the chart and notice how fast the move was. In a few hours, the price climbed up to the 161.8% extension line which was strong resistance and the best exit point.
Right afterward, there was a strong selloff. Those using the lagging indicators probably ended with a loss.
Let’s take a look at how this Fibonacci strategy can be used in a downtrend. On the chart below we have a WTI oil daily chart. The trend is down, so we look to take a short position (sell WTI). It is easy to find the AB swing. The correction ended at point C (78% retracement line). We wait for a breakdown below point B where we enter a short position. The move down was very strong and it ended at the 200% extension line.
Where to place the stop loss in the safe scenario?
In this scenario, you place your stop loss not so far away from the entry point. You assume that a break above the last peak should lead to a strong move. If, after a while, the price failed to move forward and comes back to the retracement levels, there is probably something wrong with the trend strength (at least at that moment). You do not want to wait and see if 38.2% or 61.8% will hold as support because the price was there already and you have a position opened at the last peak! What you want to do in this case is closing the position as soon as something goes wrong.
My advice is: when the price moves back below the 23.6% retracement level, close your trade. Of course, do it with the stop-loss order – do not wait and hope for the best.
The stop loss behind 23.6% is only my recommendation, but feel free to change it. Maybe you will want to have a tighter stop? Then try to set your stop loss order behind the 14.6% retracement line (it is also a retracement level, but I have hidden it on my chart).
Setting the stop much wider behind 23.6% is not a good idea in my opinion. We hunt for a strong move forward to the extension line. If the price does not move in that direction, this trade should be closed by our stop-loss order.
Wait for candle close
If you look at the 1-hour chart, each candle closes after 1 hour and there is another candle on the chart.
This is a very common mistake – traders try to be catch move and they open a trade not waiting for a candle close. As a result bullish candle (when they open a trade) closes as shooting star because Fib level worked as resistance.
Check this chart:
If you trade on 1h timeframe and want to open a short position than you can:
- wait for close of 1h candle
- if you want to entry early then switch to lower timeframe (for example 15m) and wait there for close of 15m candle
The game plan
With this method we want to enter a trade earlier, somewhere between points B and C, after a confirmation signal:
The first few points are the same as in the previous method, but they differ later on.
1. Identify the main trend. You should know what the main trend is and which direction you will be looking in to enter a trade.
2. Identify the low-high/high-low swing. Find the swing which you will draw the retracement and extension lines from.
3. Wait for the correction to part C to end. When there is a bounce back from the retracement line, get ready.
4. Wait for a confirmation signal. When there is a signal, enter the trade.
5. Close the trade at one of the extension lines (later I will show you how).
I will write more about confirmation signals in a separate part. Now, let’s focus on the logic behind this method.
You know what the trend direction is, so you know in which direction you will be opening the trade. After a low-high swing, you wait for a correction to point C. You wait for the price to accept the retracement line as support (or resistance). When the price goes back to move in a trend direction, there should be a signal somewhere between point C (retracement line) and point B.
What kind of signal? It depends on the trader. It may be a signal from the price action, oscillator, trend line or moving average. There are some good candidates here. You will read more about it shortly.
Let’s take a look at the example. The signal was a break above the resistance line.
You enter a trade between points B and C, that is, earlier than in the previous scenario. Because of that, your possible profit is larger.
Where to place the stop loss in this scenario?
Again, the stop loss should not be placed too wide. There are a few scenarios here when it comes to setting the stop losses.
C ends at 38.2%
The move is wide and the retracement levels are far away from each other. You decide to enter after the correction to the 38.2% line. My advice is to place the stop loss behind the next retracement line or the recent low. Remember, it was after you entered the trade with your signal.
On certain occasions, when I confirmed that the main trend on a higher time frame was very strong, I would place a wider stop loss (below 61.8% or 78%). The reason for that is that even if my signal was false, I still assumed that after a deeper correction, the price would go with the main trend. However, when the AB swing is very long, then the retracement lines may be far away from each other (a bigger potential loss).
This is a tricky trade. There is always a chance that the price will go lower, to the 50% or 61.8% retracement. When you place the trade, you are not 100% sure that point C was at the 38.2% line.
If you still decide to open the position between 38.2% and point B, open a smaller position and add later, after the breakout.
Nowadays, in most cases I enter a trade between 61.8% and 88.2%. Thanks to that I have better risk reward ratio. Of course, there are times when I open a trade near 38.2% but I need to have a good confirmation for that (confluence, trendlines etc.).
C ends deeper
When the correction is deeper, up to 50% or 61.8% Fibonacci level, I place my stops behind the 78% line or recent low.
When C ends on the 78% retracement, I place my stop behind the 100% point (that is, below point A).
These are only propositions of where you can place your stop losses. You should test various scenarios and choose the one that works best for you. Always remember that the most important rule is to protect your capital.
The confirmation signals
When you decide which direction you want to open position in, you have to know when to do it. It is a good idea to define a set of entry and exit signals that you will follow. This way, you won’t be making trading decisions based mostly on your emotions.
It is not enough to define a correct trend, draw the retracement levels and enter the position blindly between points A and B. You should have some signal to enter and exit. First, let’s focus on the entry signals.
50/100/200 moving average
I use often the 50 moving average (50 MA) to open a trade. This is an important MA and, on many occasions and you can use it in few different ways.
When the price closes above that average, it is a sign that the sentiment is changing. As on the chart below, after the correction to 78%, I would wait and enter after the candle closes back above the 50 MA (red line).
Other scenario is to open when average is near retracement line. You should wait for confirmation from the price. In the example below we saw a correction down to average and 38.2 retracement, retest and move up.
I used 50 average in these examples but you can use 100 or 200 if you prefer them.
The moving averages crossover
Some traders like to wait for the moving averages crossover. Of course, this is a lagging signal, but that is what we want to have. We want confirmation that the correction might be over and it is a good moment to enter the position.
What periods of the moving averages are the best? It is up to you. Some prefer faster MAs (you get a signal earlier, but there is a higher risk that it might be false), whilst others like slower averages.
In the example below there are two simple moving averages: 10 SMA (red) and 20 SMA (blue). The main trend is down, after the correction up to 78%, the price falls back. When the red MA crosses with blue MA, we get our signal to enter a short position.
Try to use the moving averages of other periods, 10 and 20 are the example here. Test other combinations, such as 5 and 15, 8 and 13, 8 and 21, 20 and 33, or if you want to use slower MAs, check 33 and 55.
Some traders trade on 4-hour Eur/Usd and some MAs work better than others there. Other traders prefer Eur/Usd, but on a 5-minute chart, and here other MAs may be a better choice. Can you see how many combinations there can be? You have to learn how to choose the best MAs for individual stock, index or currency.
The trend lines
Sometimes you do not need to use tools like the moving averages. If you have some experience in drawing the trend lines, it is also a good way to look for where to enter the position.
In the example below, the price is in a downtrend. When a correction occurs, we can draw the trend line.
The price moved to the 38.2% Fib level and down below the green trend line. It turned out that this was a false signal. In the next move, after hitting the 50% level, there was a break below the support line. This signal was correct and it was a good place to enter the position.
The Williams %R as confirmation
You can use oscillators as a source of a confirmation signal. If you have your favorite oscillator, test it and check what signals work as best confirmation.
My favorite one is the Williams %R. Most of the time, I use it for 33 back periods. For timeframes lower than 1 hour, I use 55 periods.
It is a slightly different oscillator because its range is between 0 (at the top) and -100 (at the bottom). When the line is between 0 and -20, then the price is overbought. When the line is between -100 and -80, the price is oversold; similarly to the stochastic oscillator, but the levels are different.
What I look for as regards the Williams %R are two things:
1. A break of important support/resistance on an oscillator – I use it especially when the price action is not clear to me.
Many people do not know that you can draw support, resistance and trend lines on the oscillators also! I find it to be very useful. When the price action is too blurry for me, I look for some tips on an oscillator chart by drawing the trend lines there.
2. A break in the overbought or oversold area.
In an uptrend, when there is a correction, I look at the oscillator and wait until its value is back at the -20 level and then I enter a long position.
In another example, there is a strong trend down. There is a correction, but the price action is not that clear. What I look for is the %R back at the -80 line. When it happens, I enter my short trade.
In my Fibonacci trading, I find this to be quite good and effective. With good money management and using the Williams %R, your results should be better.
Below you can see a weekly chart of copper. After the correction to the 38.2% retracement line, the price closed back above the 50 moving average. This was the entry signal, and it turned out to be the right one.
I only use this method strong trends like the one above. When the trend is weaker, it is possible that this signal may be a false one.
Another WTI example. The black moving average is a 200 SMA. You can see that it worked as support for a long period of time (the blue rectangle). Next, there was a correction to the 78% retracement line and a move back below the 200 simple moving average. When the price closed below that line, it was a good place to enter the short position. Why? Something changed. Suddenly, the MA stopped working as a support and the price moved below it. That was the sign for traders.
In another example,a daily chart of oil is presented. It is easy to draw the resistance line. After the close above it, there was a good place to enter.
The range and Fibonacci trading
It is not always so easy and obvious to trade with the Fibonacci tools. Not every move is a clear A to B, correction to C and then strong move up to point D at the extension. Sometimes, the correction to C may last longer. An attempt to break towards the extension may be a failure.
On the chart below you can see that the correction ended at the 38.2% retracement level, but the price failed to move up to the next high.
You can see that, from that moment, the price moved in the range between the last high and the 38.2% line. Eventually, it broke up but, for a long period of time, it was not going in any particular direction.
This is something you can see on numerous occasions. The price range will often be between the recent high/low and the Fibonacci retracement levels.
The move will not always continue in the main direction. A range means that there is no winning side there at the moment. Bulls and bears are struggling, eventually, one side wins.
In the example below, the main trend is up, then there is a correction, but the bulls fail to move to the next high. For a while, there is a range move, but, in the end, the bears took control and the Eur/Usd price started to fall.
In the foregoing chart, we could observe a narrow range. There are also wide ranges. A good example is a daily chart of Eur/Usd. Here you can see that the 78% and 61.8% lines act as strong resistance in the range move.
Notice that this rage lasted from May till September! All that time there was no clear direction and investors were confused. That is why it is good to know that, on numerous occasions, the range is between the Fibonacci levels. The best thing about it is that you can trade it.
In order to do this, you can seek some help with oscillators, such as stochastic, RSI or ADX. The idea is simple here – you buy at support and sell at resistance. It sounds simple, but it is quite hard at the beginning. It is far different from the trend trading, but still, you can make money in a range. As you can see above –these skills are sometimes useful.
Way no. 1 – old school approach
The tool we will be using to define the exit point is the Fibonacci extension. If you do not remember what it is, go back to Part 3 and read it once again.
There are some rules which traders follow – they look how deep the correction was. Based on that they select exit point according to the table:
|Correction to:||Look for the exit at the extension of:|
The best way to explain this method is upon examples.
Let’s assume that we have found an uptrend. We wait for a correction to enter a long position. Correction is shallow, only the 38.2% retracement line. We go long and now there is a question –when to close this trade? Many traders follow the rule that the move up from the 38.2% retracement may end at the 138.2% extension line (exactly as in the table presented).
It is not something written in the stone. They are simply aware of the statistics and probability. They know that there is a big chance that the move will end or stop for a while there.
Check the daily chart of Eur/Usd. The small correction ended at 38.2% and after that, the price continued to move up. Eventually, there was resistance just at the 138.2% extension line.
When the correction is deeper, there is a greater chance that the continuation of the main move will be stronger. As you can see in the table, a correction to a 50%, 61.8% or 78% retracement may lead to a stronger move up to the 161.8% extension level.
In next example, there is an hourly chart of SPX index presented. From a higher time frame, we know that the main trend is down. There is a correction which ended at the 61.8% extension. Pay attention that this is just below the 200 SMA – this is information for traders that the move may end there. We saw a bearish candle and sellof from here, the SPX moved down exactly to the 161.8% extension. So as it can be seen in the table – there is a move from 61.8% to 161.8%.
On the daily EUR/USD chart, there was a correction down to the 50% retracement. Then, buyers came back, the 200 SMA (strong resistance before) was broken and euro started to move up strong. The move lasted up to the 161.8% extension.
Does it always work like this? Should you simply buy at 50% and sell at 161.8%? Is it that simple? No, it is not. It does not always work like this. In the example below, after a shallow correction to the 38.2% line, there was a strong move up to 161.8%.
Has there been anything wrong with the table from the very beginning of the chapter? No, the table is just fine. You have to understand that it is about probability. As I mentioned before, there is a chance that the move from the 38.2% line would extend to at least 138.2%. It sometimes ends before that Fib level, and sometimes the price moves further on.
How to use the table?
You have seen some examples of situations when the connections between the correction and extension movements are very accurate. There are cases when they are not so useful. So, when to use the table? Whenever you are in doubt when to close your trade, it is wise to follow this rule. Remember, we are not here to catch bottoms and tops. We just want to make money. When you see that the price action is fast and you are confused about it, follow the table.
You can connect this to the money management system. Divide your position into 2 or 3 parts. Close the bigger part at the extension level based on the table. Let the rest of the position catch the rest of the move or scratch it when the price return.
Let me assure you that, having a plan of when to exit, you place yourself in the top 20% of traders. The remaining 80% have no idea when to exit. They just go with the flow, hoping for the best. In the meantime, you make money.
Is it perfect? No, but it is a plan and you can include it in your Fibonacci trading plan.
Setting an exit place
When you are placing an exit order, it is a good idea to place it just before the level you plan to exit at. You should practice it yourself, but my advice is to place exit orders a few points earlier than the exit level.
There are two reasons for that.
Sometimes, the price will not touch the extension line, like in the previous examples. It may miss it just by a few points and it will still be a valid move to the Fibonacci extension line.
Another reason is that when the price reaches a certain extension line, you are not the only one trying to exit. The price might just touch the line and move back fast and your close order may not be completed.
By setting an exit point just in front of the extension line you increase your chances to close your trade with profit.
Surely, on certain occasions, the price will move beyond the extension line. That is the life of a trader. The most important thing is to have a plan which can give you good exit points.
Way no. 2
Closing a trade is very important, yet it is not so easy. We want to exit at the very best moment, but it is hard to tell when this moment comes. What is worse, the price very often climbs slowly to a certain level, and then suddenly it can fall hard.
Trying to exit at the top does not make sense because there is always a chance that there will be another top and this one is only a stop. Be not concerned about catching tops.
In order to define a good exit point, we have to connect the Fibonacci extension levels, technical analysis, and money management. With this, it is easier to decide when to close the position. I am not going to cheat you – on numerous occasions, you will close your trade too early or too late. It is normal and you have to work on your exit strategy to make it better.
Any exit plan is better than simply letting the trade run and hoping for the best.
Thanks to the Fibonacci extension we get the potential levels where the price will stop, or where even the whole trend can stop and reverse. As you have seen in the previous chapter, it can be very accurate. The problem is that we do not know which of those levels is going to work.
That is why we use money management. You can read more in the chapter about money management, and now I will show you a good way of using the MM in closing trades.
When it looks like that you have been correct and your trade is profitable, you move your stop loss to the entry point. This way, even when the price moves back, you will protect your capital.
The 3 parts rule
You have to divide your position into three parts. You select three extension lines as your targets. For example, you close the first part right at the 127% extension. If the price still goes according to the trend, you close the second part at the 161.8% extension (or at 138.2% if you think that the trend is not so strong). You let the third part to rise and you can close it manually at a different extension level or after a trigger from technical indicator.
This way, you protect your profit, but you let it grow at the same time.
In the example below, the correction ended at the 61.8% retracement level. The entry signal is the close of the candle above the 50 moving average. When the trade is profitable, the 1st part is closed at the 127% extension. It continues to rise, so the 2nd part is closed at the 161.8% extension. The 3rd part is still open. You can close it manually at any moment.
This trend is strong, but if you are in doubt, you should close the 2nd part at the 138% extension.
Sometimes, only the first target will be hit and the price won’t reach the next Fibonacci level.
In the example below, a downtrend can be identified. The correction is deep, up to the 78% retracement level, the entry point is after the close below the 50 MA.
It is going nicely down to the 127% extension, where the 1st part of the position is closed. Suddenly, buyers show up and start to buy. The price reverses and starts to rise. There are still 2 parts of the position open, but the stop loss is raised to the entry point. It is important to remember to raise your stop loss to the entry point while managing your trade.
The rise continues and eventually we get stopped out, but still, we close the trade with a profit. All thanks to the 1st part closed at the 127% extension and the raised stop loss.
This is how it works. At times, you get lucky, the trend is strong and you close all three parts at higher levels. On another occasion, you will be stopped out with a loss, or only a small profit from the first extension level.
If this rule is a too complicated for you, start from dividing your position into two parts. When you manage your trades carefully, you should be making good money on it.
This is the main way I manage my trades, but you may want to choose some technical indicator to confirm the exit signal (for example for parts 2 and 3). In such a case I would recommend something simple. Just lower your time frame. If you trade with a 4-hour chart, lower it to a 1-hour trading trading chart and watch the reaction of the price and the extension levels closely. You can draw some short moving average (5 or 10 periods) as help.
How to define a trend?
The key to successful Fibonacci trading is to trade in the direction of the main trend. That’s the first thing.
Next, you draw the retracement levels. You want to enter the trade with a better price. You do not want to buy blindly at some random place and guess the direction of the trend. You define the trend, wait for the correction and take a position in the same direction as the trend goes.
If the trend is up, you go long (that is, you buy).
If the trend is down, you go short (that is, you sell).
When there is no trend in place, you do not take any position.
It sounds simple, but it is not that easy to define the correct direction of the trend. Unfortunately, it is necessary to open a position in the right direction to make money. If the trend is up and you go short, you will most likely end with a loss.
What is worse, if you make a mistake and define the trend incorrectly, you might be fooled by Fibonacci, because it works in both ways. Let me show you what I mean. Below you can see the retracement levels and a bounce from 61.8%. Looking at this trading chart you might think that going long is a good idea.
Unfortunately, going long is a wrong decision, because the main trend is down, which you can see on the bigger trading chart:
Notice that there is a price bounce from 61.8%, but the main trend is down! You should look for other Fibonacci retracement lines so that you can enter a short position (not long).
You will not be 100% correct every time when it comes to deciding in which direction you should draw the retracement levels and place a trade order. You should have some tools which will help you to recognize in which direction the main trend goes.
There are many tools to choose from, but I will give you some propositions. Test them and choose the one which works best for you.
Look at the trading chart from a distance
This is a well-known piece of advice and it works. Leave the price only on the trading chart and zoom out. What is the direction of the trend? You should be able to spot it easily. If not, there might not be a strong trend at the moment.
If you are confused, some say you should look at the trading chart with the eyes of a child. It is not as silly as it might sound like. Children do not overanalyze things. If something is black, it is black. If the price goes up, then it goes up. Children do not look for some hidden message which other might not know about. Next time, just look at the chart from a distance and try to define the trend at first sight.
On the trading chart below, the main trend is definitely up:
Identify highs and lows
When the trend is up, the price makes higher highs and higher lows.
When the trend is down, the price makes lower highs and lower lows.
If you are not able to identify these points, there is a chance that the price is not moving in one direction.
This is a simple technique and you just need to practice it. You can start with using a line chart only, as it is easier to read, but in the end, you should use a candlestick trading chart with japanese candlestick.
Use the technical analysis tools
You can use the technical analysis tools as help in identifying the current trend. It might be something as simple as the 200 simple moving average. When the price is above that line, you only look for long positions. When the price is below, you only go short.
It is a very simple and yet, an effective tool. Of course, you may want to use a shorter moving average like the 100 SMA. Some traders use an even shorter MA, such as a 50 or 30 periods long. It is up to you.
On the chart below, the price is above the 200 SMA, so you draw the retracement levels only to look for long opportunities.
My set of tools
I personally use the template from Part 8. If you prefer to start with something simpler, try three moving averages:
The 20 linear weighted moving average (typical price)
The 35 linear weighted moving average (typical price)
The 50 linear weighted moving average (typical price)
If the 20 MA is above the 35 MA and the 50 MA, and the 35 MA is in the middle, then the main trend is probably up and I open a long position.
If the 20 MA is below the 35 MA and the 50 MA, and the 35 MA is in middle, then the main trend is probably down and I only open a short position.
If I am not sure what the current trend is (for example, when the moving averages are mixed up), I hold and do not trade.
The importance of the higher time frame
Now you have the tools to enter the position and you know how to manage your position to exit at a good moment. If there is a trend in place and you have correctly identified the direction of the trend, you are halfway to a successful trade.
Next, you have to choose the correct swing to draw Fibonacci levels, enter the position at the correction and exit at the extension. It sounds simple and it is just that – if you are investing in the right direction.
It may be a huge problem because sometimes the trend is not so clear to see. The trend may be there, but the price action may seem very mixed up to you. Which direction is it anyway? And which swing should you choose? How to avoid confusion?
As a smart person, you probably know the answer, basing on the title of this part. The higher time frame is a vital help.
You have to learn how to use it every time when you are in doubt. Testing the higher time frame is a good idea because it gives you the answers to your questions.
It looks like an uptrend, but is it one? On the 4-hour chart you can see that, in fact, the trend is up after some correction:
That way you get a clearer picture of the current situation.
Remember: if you are not sure about the direction of the trend, check the higher time frame.
There is one more important thing I would like you to remember and use. It increases your chance of success substantially.
The rule is simple:
Always trade in the direction of the trend from the higher time frame.
An example may be very helpful here to convince you to use the rule. Below you can see a 15-min chart of Eur/Usd.
Clearly, there is a trend change and you can spot the correction. When you draw the retracement levels, it looks as if it was working. So, is it a good place to go short?
In order to make sure, we check the higher time frame. Below you can see the same pair but on a 1-hour chart.
Wait a minute! Going short was a bad idea because the main trend is up. That was only a correction. Notice that the retracement levels seemed to fit perfectly. It looked like the 38.2% retracement level was going to stop the price. As I have mentioned earlier, you have to be very careful because the Fibonacci retracement levels work both ways and it is your job to identify the correct trend. In the example, it looked like you should the draw retracement levels for a short position, but the higher time frame gave you an answer not to.
In another example, we look to take a long position at the S&P500 index. On a 1-hour chart it looks like an uptrend, and there is a potential swing where we can draw the retracement levels:
In order to make sure, we check with the higher time frame, in this case, on a 4-hour chart. When you look at the left side, there is a clear uptrend.
The correction ended and new highs were made, which stopped at the 138% extension from that move.
The logic behind this is obvious. The trend from the higher time frame is going to last longer, so it is stronger. When there is a correction, on the lower time frame it looks like there is a change in the trend direction. However, it is not the truth.The correction ends on the higher time frame and the price moves in the previous direction.
Remember about that simple rule and always invest in the direction of the higher time frame. This way, your win/loss ratio will be much higher.
Fibonacci trading and the news
If you want to trade in the Forex market, you should be aware of the news schedule. Every day there is a lot of economic news from many countries. Most of it is not so important, but there is some news that the market waits for and reacts strongly to their announcement.
If you trade Forex, you should know what economic data will be published. You can check this, for example, on forexfactory.com. In a table on the site, there is a column named impact, which represents the impact of the news on the market.
Some of the most important news is the rate decisions and the non-farm payrolls (NFP).
The US non-farm payrolls are published at 1.30p.m. (London time) on the first Friday of each month.
The US non-farm payrolls release is one of the most closely watched US indicators and is considered one of the best gauges of the US job creation.
The labor market is critically important for the US economy, with unemployment levels playing the leading role in the perceived strength of the current economic recovery. Consequently, the policies of the Federal Reserve may be influenced by the non-farm figures.
Nowadays, all markets are volatile and it is a good idea to trade less or even not to trade at all.
But there is a way you can still trade with good results. The Fibonacci tools are very useful here.
Before I show you how can you trade the news, there will be an important warning.
When you try to enter a position at the time the news is published, there might be a slippage. It means that the difference between the ask and the bid price may be considerable and the cost of entering the position may be very high. Check with your broker what their policy about slippage is.
The advice is to risk only a very small part of your capital for trading the news.
A lot of things can go wrong here, so do not risk too much!
You know the risk now, so let’s see how to trade the news in practice. I will show you a chart from the time when the NFP numbers were released. You can trade on the major pairs or main US indexes. In the examples below, I am going to use the SP500 chart.
The main idea is that the NFP release very often (but not always!) leads to a stronger move. This move is very specific. The first moment after the news release, short-term traders are opening and closing positions – that is why there are a lot of messy moves. We do not want to trade the market like this, so we wait. After the news release, the data is known. Many investors holding back before the release get back to trading. That is why the market starts to trend stronger. Where there is a trend, there are also corrections, and we can use the Fibonacci tools to enter and exit positions.
Look at the 1-minute chart from December 2nd. After the release, there was quite a mess for 5 minutes, but after that time a strong trend occurred.
You can probably see the retracement and extension clearly now. Yes, it is perfect to play with Fibonacci.
My advice is to exit at the extension level. Do not wait too long. When I trade on the news day, I usually divide my position into two parts. I close the first part at the 127% extension line, and the second at the 138.2% or 161.8% extension (depends on the price action).
What is interesting, later that day there was a number of strong moves. It was probably because after data was revealed, investors were taking positions again. You can find a lot of good situations to enter the short term position. For example, later the same day there was another good trade chance. When would you enter and exit?
This was a good day to practice your Fibonacci trading skills. There were a lot of opportunities where you could use the Fibonacci retracement and extension lines, but you had to make decisions quickly – in which direction should you open the trade? This is a very good opportunity to practice, but – again – the risk was greater here! Remember about smaller positions!
What markets can you trade with Fibonacci strategy?
Answer is short – you can trady any market with Fibonacci strategy.
We are talking about forex trading stocks trading, commodities and so on. Some people prefer forex market, some like to invest long term in stock. You can be in any o this group and use Fibonacci trading.
It does not matter if you are day trading or swing trading. You can use Fibonacci levels on any time frame – low like 5 minute or 15 minute to time frames like daily, weekly, monthly…
Remember about basics we covered in this guide. You look for market which is trending and has good liquidity. There are times when each market can be in a range move but if you observe closely you notice that some markets/instruments stay in a range longer than others. For example, compare Forex Yen pairs like GBP/JPY with USD/CHF. You will notice right away strong trends and short periods of range moves on yen pairs.
When market is trending, you can use Fibonacci strategy and have better results.
Other Fibonacci tools
There are a number of Fibonacci tools you can use. Why is there so much information in this guide about the Fibonacci retracement and extension lines and so little about other tools? It is because I base my Fibonacci trading plan on these tools and they are enough to trade successfully. So should you use other tools? Yes, but there are some things you should be aware of.
Using them all at once may be very confusing and you may end losing money because of information overload. When you draw your retracement, extension, time zones and fan on one chart, you see such a big area of support and resistance that it is simply too much. Do not do that.
It is very important to learn how to use tools like the retracement and extension first in order to be comfortable with them. Then, you can move on and use other tools, such as fan or arcs. You will understand how they work very quickly because the logic is similar to that of the extensions and retracements. You can find the 38.2%, 61.8% and other Fibonacci levels working as support/resistance, so it won’t be something totally new for you.
What are Pivot points?
I want to show you how you can be more profitable by combining two leading indicators: Fibonacci and Pivot Points.
First, a short introduction to Pivot Points. The topic is wide and you only need some basic understanding of Pivot points, because the main trading tool will still be Fibonacci.
Pivot points are a set of horizontal lines calculated on the previous bars. There is a whole mathematical formula behind it, but as a result, you get the Pivot point line, which is always in the middle.
Above the Pivot line, there are also the resistance lines called R1, R2, R3 (you can count more, but the price rarely moves up to R3).
Below the Pivot line, you can find support lines called S1, S2, S3.
Below, you can see a 4-hour chart of Eur/Jpy with the daily Pivot points:
The logic behind this tool is that the price will rise, but eventually, at some point, it will be oversold and it will be very hard for the buyers to force the resistance line. The R1, R2, R3 lines are calculated on the basis of the previous bars and help you determine where the resistance and overbought area might be. When the price is overbought, there is a strong chance that a correction may occur. Then it may take the price down to the Pivot line – that is, to the middle. If the move is strong, it may take the price even lower to the support levels S1 or S2.
On numerous occasions, this tool may be very accurate, so it is good to have it on the chart from time to time.
The most important levels to watch are the S2 and R2. At S2 many sellers close trades and buyers try to buy there. There is a chance for a strong bounce from the S2 level.
At R2 many traders close transactions and open short positions. A strong sell-off is possible at that level.
A monthly, weekly or daily Pivot?
There is one more important thing you should know. There are different Pivot point types. We can draw monthly Pivot points, weekly Pivot points, daily Pivot points, and even 4-hour or more frequent ones. It is all because they are counted on the previous bar, so you may have the previous bar of the month with its high, low, close and count Pivot points for this month.
So as not to confuse you, I will suggest which Pivot points you should use. It all depends on the time frames you trade most.
You mainly trade on very low time frames: 1-min, 5-min…30-min…1-hour – you should have daily Pivot points on your chart. Weekly points are optional – if you want, you can have them too, but it is not necessary.
You trade on medium time frames: 4-hour or daily ones – you should be aware where the weekly and monthly Pivot points are. You should check the daily Pivot points only when you are opening a trade (not to open it at the daily R2 line).
You are a long-term trader. You trade on high time frames: daily, weekly or monthly ones. You should mostly have the monthly Pivot Points or even the quarterly ones.
Should you have all these drawn on your chart? No, unless you want to. It is very hard to read a chart when you have so many indicators on it.
When I trade with Fibonacci, I start a day with identifying the kind of trend there is, and then I check where the major resistance and support levels from Pivot points. Sometimes, I make a note and sometimes I just open another chart with the same index, stock or whatever I am trading at the moment. On the first chart I have the levels from Pivot points and on the second one, I only have a few moving averages. When it comes to Fibonacci trading, I can quickly check if this is a good point to enter or exit a trade.
How to use Fibonacci levels and Pivots together?
Fibonacci and Pivot levels may give you an idea of where the strongest support or resistance may be. This way, you know better when to open and close the trade. I usually look for a convergence of the Fibonacci retracement line and the Pivot support line (S1, S2, S3) when I want to open a long position in an uptrend.
Let’s have another look at the example where I showed you the Pivot points on the Eur/Jpy chart. We can draw the Fibonacci retracement lines. Notice that when we do it, there is a clear convergence of the daily S2 level and the 50% Fibonacci retracement line. If you are looking to enter a long position, it is a great point to do that.
In another example, there is a trend up, and during a correction, I go long. Over time my trade gets profitable, but I have to decide when I should close it. I trade on a 1-hour chart with weekly and monthly Pivot points. I look for the nearest resistance and I see that the nearest one is the weekly R1 line.
As stated before the most important are S2 and R2, but at R1 and S1 you can also expect some reaction, even if only a few hours long. Since I am opening the position for a short period of time, I do now need to check if there will be some reaction.
My extension level 118% is almost exactly in the same place as the weekly R1. Here we have a convergence of the Fibonacci extension line and the Pivot point resistance line. This is a red light for me. Now I know that I should not wait to see if the price goes up to the 138% or even 161.8% extension. I want to protect my profit. Of course, the R1 level is not a brick wall and the price may go through it. In some cases, it will move back and there will be a correction. I do not wait and I close the position at the 118% extension. Later the price moved a little bit higher, but as you can see, it went back, as a result.
I have my profit and I can hunt for another trade. I hope that you can now see why it is a good combination of tools. I still make my entry and exit decisions basing on Fibonacci, but Pivot points help me to decide when this entry and exit should take place. When I see a convergence of Fibonacci and Pivot lines, it is a very important sign for me that this level may be a strong resistance or support. Compare this technique with some trend following systems – how slow and lagging are they in comparison?
It is like the information you heard on the radio that the road you are on is blocked or very icy. You can decide if you want to go back, select other route or just keep driving but try to be very careful.
Another, similar example: this time the price went higher above the weekly R1 resistance. Let’s say you take a long position here and you are now in profit. When should you close the position?
As you know after reading the previous parts of the book, I suggest dividing the position into two or three parts. The first target here would be the 127% extension because in the same area you can see the monthly Pivot. The price continues to rise and there is still part of the position open (let’s say, another half in this case). You decide that the price is moving strong and there is a weekly R2 level ahead. You notice that just below the weekly R2 there is a 161.8% extension of the previous AB swing. At which level should you close it? In that case, the weekly R2 and 161.8% are very close to each other, so it is a good idea to close the position at this point.
Another way is to open the same chart and check the lower time frame. Sometimes the price tends to overshoot some resistance and then go back below. When you see the first signal of the price moving back, you close the second half of the position. In the example above, the price almost touched the weekly R2 (missed it only for 4 pips), but the 161.8% extension was holding the price.
From the beginning, this trade was intended as a short-term trade. Do you wait with opening the position and hope that the price will move up even more? As you remember the R2 levels tends to be a strong resistance. In the example above, it was Thursday when the price reached the weekly R2. Of course, there is a chance that on Friday there will be a continuation of the move up. But what if there is a correction and you still wait with your position open? You are going to lose most of your profit because the corrections are often very strong and fast.
When you follow my advice and you close your position in parts, you protect your profit. If you believe that there is a chance for the move to continue up, just leave 1/3 of your position open and watch how it goes.
Keeping the whole position open under the weekly R2 and 161.8% at the end of the week is not a good decision – you have to trust me on this one.
At the end of this guide, you can find instructions how to install Pivot points in the MetaTrader software. If this is too much information for you on one chart, just open another chart with the same index, stock or currency. Look how Fibonacci and Pivot point lines work great together sometimes. When you spot the convergence, you are much ahead of other traders!
Money management is very important. In my opinion, it is as important as the technical part of trading (in our case, trading with Fibonacci). You may be a great Fibonacci trader, but without good money management, you are still going to fail.
What does good money management mean? It means that you do not risk too much of your money and even after a lost trade you have the capital to invest and build your wealth.
It is not enough to decide that you are not going to take risky trades. You are not able to switch off emotions completely. And where there are emotions, there are also mistakes. That is why you need a good plan. The best way is to write it down and correct when necessary. This plan should contain several positions:
• Your trading account size
• Maximum risk
• Where you place stops
• When you take profit
• Number of lost trades you stop trading after
Stop losses and the 1% rule
Some traders prefer not to set stop losses because they are afraid of “stop-loss hunting”. I will not tell you what you should do, but unless you are a very experienced trader, forget about that and always set stop losses. It does more good than bad and it can protect you from a bigger loss. Let’s assume that you haven’t set the stop loss. Suddenly, the price falls down instead of rising as you wished. And it falls hard. You want to close the order, you know that it is something you should do, but some voice tells you to wait. It is all about trading psychology and it is nothing new. You try to convince yourself that this is only a correction and it will end soon. Yeah, sure…
With a stop loss in place you curb your emotion levels to the minimum, so you do not have such doubts.
The other important thing is how much you should risk. You have probably heard about the 1% rule. Yes, 1% is not much, but it is a good rule. The main idea is that you shouldn’t risk losing more than 1% of your whole trading capital. So, if your trading account is 10000$, you shouldn’t risk more than 100$. I know what you are thinking right now: “with this rule, I will have to place very small positions”.
Yes, if you want to place bigger positions, increase your account size. I know this is hard, but you cannot count that you will get lucky and make 100.000$out of 1000$.
Without a proper account size you are not able to create a good money management system, and therefore, most probably you are going fail soon. This is the harsh truth.
It is true especially in our case when we use the Fibonacci tools. Entries are fast, stop losses are tight, and our main goal is to get a few points of profit on the bigger leverage. To be able to do that, you must have enough money to invest.
If you are short of money but want to make millions, you start to take very risky positions and, as a result, you are probably going to lose everything.
What to do if your account is not big enough?
Do not worry if you do not have enough cash right now. Simply trade on the lower leverage. Thanks to this you will be able to keep the 1% risk ratio. Do not think that you are not going to make any good money with such small positions. Okay, you are probably not going to. But what you are going to gain is valuable experience and knowledge. It takes a lot of time to learn how to trade successfully. Use this time to figure out how to get more money that you can later invest.
This way, when you get enough money, you will be ready.
This is the right path to succeeding in investing. A very small percentage of traders have got rich starting from small amounts, such as 2000$.
Just stick to the 1% rule and you will be in the 10% of best traders who follow their money management.
What if I still do not like the 1% rule?
Look, I get it. It is not something easy to use, but this is a great tool to protect your capital, mostly from your grid and to keep your trading psychology in check. If you still want to risk more than 1%, and you believe that you are ready for it, I will give you some advice. Divide your trading capital and pay it into two separate accounts. It is best to keep an 80:20 proportion.
Now you have two accounts –in the first one there is 80% of your money, and the rest 20% is in the second one. You are going to trade both these accounts, but with a different approach. With the bigger one, you are still going to stick to the 1% rule. It is because this is where most of your money is and you want to protect it.
You are going to trade with a bigger risk using your second account, so you can increase the maximum loss you can take up to 3-4% of your account. It may not seem a lot, but believe me – it is. If you can make good investing decisions, both your accounts will grow, even the smaller one. You are going to have bigger profits from that account because your positions are going to be quite big.
If you fail to trade successfully, your loss won’t be so painful. Of course, you are probably going to lose most money from your smaller account, but most of your cash is safer at in the bigger one.
As I have already said, I recommend using the 1% rule for all of your trading money. But if you want to trade bigger positions, try my way and divide your account into two separate ones. This way, you are going to monitor your readiness to trade big positions.If not, you should stick to the 1% rule and build your main account.
Raising the stop loss order
I have discussed this before, but let me explain it more deeply. You should remember to raise your stop loss order when your trade is profitable. You do not have to rise to entry point immediately, but you can do this step by step.
You can plan it in advance. For example, my plan looks like this:
I open a position and set the stop loss (for instance) 10 points below the entry point. The price is rising and is about to break through the recent high (point B). I raise my stop loss and it is now only 5 points below my entry point. The price continues to rise and my first target (the 127 extension) is hit. I close 1/3 of my position and raise the stop loss up to the entry point. At the moment I have a profitable trade. I have booked profit and even if things get worse and the price falls, my stop loss is at the entry point, so this will only scratch my position.
It is hard to learn to strictly follow the plan, but you should try anyhow. If necessary, write it down, print and hang over your desk.
Following the 1% rule and managing your trade by closing parts at the extensions and raising the stop loss increase your chances of success in trading considerably!
When you enter a trade, you place your stop loss in the first place, somewhere below the entry point (in the uptrend). When you see that your entry has been correct and the trend is going up nicely, you should raise your stop loss up to the entry point. This way, even when there is a strong sell-off, you just scratch your position and avoid loss.
In the example below, there is a 1-hour Eur/Jpy chart. After a break above the resistance the 200 SMA, there is a great place to open the position. You place the stop loss below the moving averages, around 97.50 points.
After several hours we can see that uptrend is strong. Our trade is in profit right now, so we can move our stop loss up to the entry point (around 98.40). This way, we can be sure that we won’t lose in that trade.
If the trend continues upwards, we can raise the stop loss, even more, to make sure that we close the trade with profit.
It is a simple rule, but on numerous occasions, it can help you save a lot of money.
Fibonacci trading works on every time frame an instrument. It can be a great addition to trade it on bitcoin.
Finding a broker for Bitcoin trading
There are few brokers with Bitcoin and other crypto coins in their offer. For example, even XM added it to their offer.
My recommendation would be a crypto account from FX Open:
You can open an account with a small deposit (starts from 10$), you have Metatrader 4 platform and cryptocurrencies offer is good.
Find all details here.
Fibonacci trading works on every time frame but for most traders, it is better to trade on the higher time frame. Especially when you trade Bitcoin or another crypto. Trends are strong here and you can catch bigger moves on higher time frames. Few examples below.
The 4-hour time frame of Bitcoin and simple ABCD trade:
The daily time frame of Bitcoin:
The weekly time frame of Bitcoin:
As you can see, on every one of them you can use Fibonacci to catch big moves.
Of course, Fibonacci works also on lower time frames, even when you trade Bitcoin. Example of 1-minute Bitcoin time frame:
You can see that it works great even on time frame as low as 1-minute. Read more about day trading bitcoin here.
You can use standard retracement lines:
We use them to spot ABC moves:
When it comes to extensions, you can use more lines. I stick to most basic ones:
- 127% extension
- 138.2% extension
- 161.8% extension
- 200% extension
- 261.8% extension
Just like on the chart below:
Fibonacci trading strategies for Bitcoin
You can use all strategies described in this guide. There is one thing to consider when you chose a trading strategy. Bitcoin is trending a lot. Because of that, you can combine Fibonacci tools with some trend following strategies like trailing stop loss or moving averages.
Trailing stop loss, Fibonacci, and Bitcoin
The plan can be like this:
- you trade with ABCD pattern
- when a price goes near your target (extension line) you close part of a trade (take profit)
- move stop loss higher
- let the rest of trade run with a trend
Like in the example below:
If you decided to trade on lower time frames (1h and lower) then it is a good idea to combine Fibonacci with Pivot lines. Below you can see how daily Pivot lines and extension lines helped to select the best exit point:
More about trading with pivot points here.
Ichimoku, Fibonacci, and Bitcoin
Ichimoku works best in trending condition. Bitcoin is trending so it is a nice combination of Fibonacci and Ichimoku. You use Ichimoku as a trend indicator. When you see – like below – that trend is up, you look for proper ABCD setup:
You can also use Ichimoku as a signal to enter or exit a trade. For example, a classic break from the cloud would be a good signal:
More about trading Ichimoku here.
Trading Bitcoin is not that different than normal trading. You can see that on Metatrader chart it looks similar to other trading pairs. You can use the same tools. Just be careful when you trade on lower time frames. For most traders, it should be better to trade longer ones.
I show you trades with use of different tools. Some examples of indicator based trading, some examples of price action based trading. The common part are Fibonacci Levels. It is your decision if you want to use Fibonacci trading strategies with indicators or not. It is just good to have some entry cofirmation, some signal which will help you to create better trading strategy.
Example 1.Eur/Jpy trade
On the Eur/Jpy daily chart you can see that there was a correction up to the 50% retracement line. Earlier, the 200 simple moving average worked as support, so it was best to wait until a price breakdown through the support. It took place at the end of April:
The breakdown here was the entry signal to take a short position at Eur/Jpy. Earlier we have identified the ABC pattern, now we are looking for point D. The move down is very strong. There is some reaction at the 127% extension line – you could close some part of your position here. In this case, I waited until the price reached the 161.8% extension – this was my point D and I closed my position there.
Later, there was an opportunity to re-enter the short position when the price continued to move down.
Example 2.Eur/Jpy on lower time frames
When you spot a situation like the one shown in the first example, remember that there may also be also a number of occasions to place good trade orders on lower time frames. When there is a break above/below an important support/resistance, lower your time frame and look for trade opportunities in the direction of the breakout. In the example there were plenty of trade opportunities on the 1-hour chart (and other time frames):
In the example above, there are two good entry signals. The first one after the break below the red trend line, the second one after the break below the support and the 0% Fibonacci line.The price went down to the 138% extension line and it was a good point to take profit. Look at the chart closely – later there was another breakdown and you could use the Fibonacci tools again to enter and exit another short position.
Example 3. Short at Nzd/Usd
In this example, we can see a standard ABC pattern at the beginning of the downtrend. The correction went up to the 50% retracement line (our point C). After that, there was a quick move down to the 127% extension line, which was the best place to take the profit or at least to close part of the position.
There are a few points you could enter the trade at, but let’s focus on the bigger picture. After the move to point D there was another correction. You could draw other retracement lines for this move, but pay attention to how the extension lines from the first move were working. After another breakdown, there was a strong sell-off down to the 261.8% extension line from the first move.
This is a good example that you should, from time to time, also look at the extension lines from earlier moves.
Example 4. Bollinger bands and Fibonacci trading
In the example below, you can see an Aud/Usd 1-hour chart. You may notice that during stronger move bands are wider and during a range/correction they get tighter.